Educational Articles

When the Going Gets Tough, Coca-Cola Gets Going

Nira Maharaj
| July 27, 2010

The Coca-Cola Company (KO - Free Analyst Report) is the largest non-alcoholic beverage manufacturer in the world. Its diverse portfolio of over 3,300 drinks reaches the most remote regions of the globe. But Coca-Cola has not been immune to the global recession, and now management has the task of shifting strategies in order to deal with the lingering impact of a beleaguered economy.

Arguably the most drastic shift in operations is the pending purchase of the North American operations of its largest bottler, Coca-Cola Enterprises (CCE). This company was spun off from Coca-Cola in 1986 when it was believed that the entities would perform better separately. Coca-Cola Enterprises would be allowed to expand geographically, while Coca-Cola could focus on a solid marketing and innovation pipeline. However, due to the recent recession, this attitude has shifted. Earlier this year, Coca-Cola formalized its intent to purchase the majority of the bottler’s assets in a deal worth about $15 billion. This came on the heels of PepsiCo. (PEP), Coca-Cola’s biggest rival, purchasing its two largest bottlers, Pepsi Bottling Group and PepsiAmericas, in a $7.8 billion deal that was consummated earlier this year.

The current action by Coca-Cola is an attempt to bolster operations and remove some non-fixed expenses. Assuming that proper financing can be obtained, consolidation in the current economic period makes sense. The acquisitions of its bottlers will allow The Coca-Cola Company to have more control over its distribution channels, and enable it to better focus its marketing and distribution processes to particular markets. Coca-Cola hopes that this will spur greater volume in the years ahead. In addition, operating expenses should be dramatically lowered as manufacturing redundancies and other operating inefficiencies are removed. In short, consolidation ought to facilitate a streamlined business, and, consequently, create a more formidable supply-chain and distribution system for the beverage titan.

Purchasing its bottlers will also allow Coca-Cola to focus on a more diversified beverage portfolio. Conflicts between Coca-Cola and its bottlers have occurred, since the bottlers are typically less enthusiastic to focus on non-carbonated drinks because they cost more to produce and carry smaller profit margins, in comparison to sparkling beverages. Thus, by consolidating, Coca-Cola will undoubtedly strive to make a bigger impact in the still-drink categories because volumes in carbonated beverages have flat lined since 2005. It appears that consumers have been and will continue to seek healthier options in light of growing obesity and other health concerns.

Hedging is another strategy that bigger companies such as Coca-Cola and PepsiCo. have adopted. These companies’ bottlers typically hedge ingredient and packaging costs (aluminum, plastic, etc.). This insulates them from escalating or volatile prices that could cause elevated production costs. Due to the economic uncertainty, Coca-Cola has also hedged against foreign currency volatility, which is currently protecting the company from the recent weakness of the euro. Coca-Cola has implemented currency-hedging throughout the remainder of the year and into 2011. This appears to be a sound strategy since the company depends, to a large extent, on overseas markets for revenue and profits, which are then converted to U.S. dollars.

The Coca-Cola Company has also formed distribution partnerships with other well-known beverage companies, namely, Hansen Natural Corporation (HANS) and Dr. Pepper Snapple (DPS). Both of these drink manufacturers have a wide array of popular beverages on the market. These synergistic efforts tend to work in the favor of all parties involved. The smaller beverage companies benefit from Coca-Cola’s vast distribution channels, while this arrangement allows Coca-Cola to bolster its product line up.

Overall, the Coca-Cola Company will probably not own its bottlers’ assets for the long term. Management recently stated that the purchases are a short-term solution to offset revenue declines due to the lackluster economic environment. On the other hand, distribution arrangements and hedging policies are likely to stay intact, which should lead to higher and more predictable earnings over the next several years.

Coca-Cola is and ought to remain the largest beverage company in the world, with a diverse and popular product lineup. It also possesses the financing and flexibility to shift its operations and marketing focus when consumer tastes change. Thus, this stock holds considerable long-term appeal, and a nice dividend payout only sweetens the potential total return. To learn more about Coca-Cola and its corresponding stock, click here to view our most recent full page report.